Japan, reasons to overweight the Land of the Rising Sun

Japan has a new hero. His name is Takerufuji. He is aged 24, weighs around 22-and-a-half stone and recently became the first sumo star in over a century to win a tournament on his top-division debut.

The spectacle of two mawashi-clad wrestlers trying to bundle each other out of a dohyō may be what most people think of when they hear “overweight” and “Japan” in the same sentence. Lest we forget, though, these words also have meaning in the investment world.

So why do we see such appeal in the Land of the Rising Sun? In this sphere, as in sumo, there is a growing sense that a new dawn is in the offing.

Japan finally catches up

There are various reasons why this market now merits more attention. Japan’s long-awaited abandonment of negative interest rates perhaps represents the most symbolic milestone. The BoJ was the last central bank to adhere to ultra-loose stimulatory monetary policy. It finally fell in line with the rest of the world on March 19, bringing an end to an era in which its economy and equity market were in retreat – not least relative to those of China and the US.

There are already signs that a lengthy period of deflation has come to a close. Some workers have received Japan’s biggest pay-rises since the early 1990s, while more companies are passing inflationary costs on to consumers.

Meanwhile, tougher governance and stewardship codes are compelling Japanese firms to better align their policies and practices with shareholder interests. This suggests genuine corporate reform is under way.

Crucially, the Japan Exchange Group, which controls the Tokyo and Osaka stock exchanges, plans to name and shame companies that fail to enhance corporate value. Amid mounting peer pressure, more and more boards are responding positively to this initiative.

Currency, keiretsu and creating value

A major question for many investors is whether to hedge the currency risk that investing in Japan entails. The weakness of the yen is clearly an issue.

Predicting currency movements is notoriously difficult, but it is possible to create a natural and cost-effective hedge. This can be achieved by investing in major exporters, such as Mitsubishi Heavy Industries and Komatsu, which have profited from the relative strength of other currencies for several years.

These can be counterbalanced with holdings in a number of cheap, mid-cap, domestic yen earners that are committed to improving profitability. Companies in this category, such as Nippon Television and Sompo Holdings, may offer decent defensive returns.

Firms with cross-shareholdings are also worth investigating. Known as keiretsu, cross-shareholding involves companies holding shares in their business partners. Calls to abandon this controversial practice have been intensifying for years, and the unwinding now taking place can be a powerful source of value creation.

There are also Japanese businesses that are more global than they might first appear. A good example is Mitsubishi UJF, Japan’s largest bank, which owns nearly a quarter of Morgan Stanley. 

Will it be different this time?

Many Japanese stocks trade at price-to-earnings ratios of between 8x and 15x. Like their similarly unloved UK counterparts, they present opportunities to buy high-quality but underappreciated companies cheaply.

Looking ahead, we believe there are numerous potential catalysts for a surge in the Japanese market. In the meantime, investors can enjoy the dividends – our Japanese holdings currently yield an average of 3%.

Granted, 3% might seem comparatively low. But it is worth remembering that this remains just about the only economy where equities yield considerably more than government bonds – and Japanese dividends are now rising more rapidly than those of the S&P 500.

Of course, just as Takerufuji is far from the first up-and-comer to be touted as the future of sumo, Japan’s revival has been teased before – only to fail to materialise. After a series of false dawns, will the story be different this time?

No-one can be certain on that score, but Japanese stocks should at the very least bring defensive qualities and steady growth to a globally diversified portfolio. At best, they could provide useful income and significant growth over the longer term.